Commentary and musings on the complex, fascinating and peculiar world that is securities regulation

Wednesday, August 29, 2012

SEC Chair Reconciles Quiet Period Rules with Supreme Court First Amendment Decision in Response to House Oversight Chair

The SEC’s quiet period rules do not suffer
from a constitutional defect under the US Supreme Court’s First Amendment test announced
in a 2001 ruling, said SEC Chair Chair Mary Schapiro in response to a question from
House Oversight Committee Chair Darrell Issa (R-CA) as part of a letter from
the oversight chair containing a number of questions on the reform of the IPO
regulatory regime.

Chairman Issa asked the SEC Chair to
reconcile the quiet period rules with the Supreme Court’s decision in Lorillard
Tobacco Co. v. Reilly, 533 US 525 (2001), where the Court used a four-part test
to determine if commercial speech fell within First Amendment protection: 1)
whether the expression is protected by the First Amendment; 2) whether the
government interest is substantial; 3) whether the regulation directly advances
the government interest; and 4) whether it is not more extensive than necessary
to serve the government’s interest.

According to Chairman Schapiro,
communications regarding registered securities offerings are neither inherently
unlawful nor inherently misleading. Moreover, there is no doubt that the
government interest is substantial. The primary purpose of the Securities Act
is to protect investors by requiring the publication of material information
thought necessary to allow them to make informed investment decisions
concerning public offerings of securities. Congress intended for Section 5 of
the 1933 Act to protect the public from fraudulent statements made by issuers
or underwriters who, in their efforts to persuade investors to participate in a
financing, might fail to disclose material information. Section 5 ensures that
investors have access to the disclosures of the material business and financial
facts of the issuer provided in registration statements and prospectuses.

According to Chairman Schapiro, a restriction
on commercial speech directly advances a substantial government interest if it
will alleviate the harms that the government seeks to prevent to a material
degree. The quiet period rules restrict the communications that encourage
investors to form a premature opinion of value without benefit of the full set
of facts contained in a prospectus. The premise of the rules is that if
investors could receive glossy promotional literature from the issuer they
might pay little attention to the dull and formalistic prospectus.

In Chairman
Schapiro’s view, the quiet period rules thus protect investors by forcing the
company to market its securities principally by means of the disclosure
document prepared in accordance with SEC rules and subject to prior review by
SEC staff. Also, requiring a company to use a registration statement and
prospectus as the means to market its securities offering to potential
investors subjects those efforts to Securities Act liabilities.

The limitation is narrowly tailored to be not
more extensive than necessary. The limitations on communications during the
quiet period are of finite duration, said the SEC Chair, thus ensuring that the
impact on speech is limited.

Chairman Schapiro pledged that the SEC will
continue to consider the First Amendment interests implicated by the quiet
period rules, but those interests must be assessed in light of the Securities
Act provisions requiring investors who receive offers for securities to also
receive the information that accompanies registration, as well as protection
from misleading communications.